Several states are turning to contingent-fee audit contractors, sometimes referred to as “bounty hunters,” as a means of increasing corporate income tax collections. Bounty hunter firms are compensated based on the tax assessed, thus encouraging these firms to aggressively assess taxpayers.

Not surprisingly, contingent-fee-based auditors are supporting legislation in several states that would require state tax agencies to enter into contingent-fee audit contracts. Contingent-fee audits are viewed by corporate taxpayers (and some courts) as unfair, hostile, and bad public policy because the auditors have a financial stake in the outcome of the audit. Washington, D.C., New Jersey, Kentucky, Louisiana, and Alabama have entered into contracts with a bounty hunter firm resulting in assessments that can reach $200 million. These assessments are based on “transfer pricing” audits that ignore a taxpayer’s tax return and instead focus on estimating a taxpayer’s income attributable to a jurisdiction by examining financial statements and other publicly available data. These assessments are being challenged in Washington, D.C.

Legislation has recently been introduced in Minnesota (House File 174, House File 904, and Senate File 740) that would require the state to issue a request for proposal to engage bounty hunter firms generally (HF 174) and transfer pricing audit firms specifically (HF 904/SF 740). Similar legislation was also introduced in Indiana (Senate Bill 589) and Hawaii (Senate Bill 756). The trend to allow for contingent-fee audits could spread given the support by private audit firms coupled with state budget pressures to downsize government agencies and the pressure to raise needed tax revenue.

In response to this disturbing trend, Sutherland is organizing a coalition of corporations aimed at fending off these efforts. This coalition will engage in traditional advocacy efforts, education of state tax departments, and efforts to influence procurement processes.